Why Do Investors Buy Shares of Actively Managed Equity Mutual Funds? Considering the Correct Reference Portfolio from an Uninformed Investor’s Perspective

Radu Burlacu, Patrice Fontaine and Sonia Jimenez-Garces

Finance, 2023, vol. 44, issue 2, 69-111

Abstract: We use the Grossman & Stiglitz (1980) framework to build a reference portfolio for uninformed investors and employ this portfolio to assess the performance of actively managed equity mutual funds. We propose an empirical methodology to construct this reference portfolio using the information on prices and supply. We show that mutual funds provide, on average, an insignificant alpha of 23 basis points per year when considering this portfolio as a reference. With the stock market index as a proxy for the market portfolio, the average fund alpha is negative and highly significant, −128 basis points per year. The results are robust when considering various subsets of funds based on their characteristics and their degree of selectivity. In line with rational expectations equilibrium models considering asymmetrically informed investors and partially revealing equilibrium prices, our study supports that active management adds value for uniformed investors. JEL Classification G11, G12, G14

Keywords: information asymmetry; reference portfolio; performance; actively managed equity mutual funds; rational expectations equilibrium models (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 (search for similar items in EconPapers)
Date: 2023
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